Restrictions on Fiscal Policy and Demand-Side versus Supply-Side Policies for Low Unemployment

Answer

Part (a) — What restricts the effectiveness of fiscal policy [10]

Expansionary fiscal policy raises government spending and/or cuts taxes to lift consumption and investment, raising aggregate demand and, via the multiplier, national income by a multiple. Its effectiveness can be restricted in three ways.

Uncertain response of C and I (poor outlook). A tax cut raises disposable income and after-tax profits, which should raise C and I. But if the economic outlook is weak, pessimistic households and firms save the windfall rather than spend it, so AD rises little. The transmission depends on confidence the policy cannot manufacture.

A small multiplier. The multiplier measures how far national income changes for a given change in AD, and is smaller the larger the leakages — saving, taxation and imports. An import-reliant economy with high marginal propensities to withdraw has a small multiplier, so any AD injection produces only a modest rise in income.

Time lags. Fiscal policy acts with delay. A tax change may affect payments only at the financial year-end; spending on infrastructure or public hiring works through the economy slowly. By the time the full effect is felt, the downturn may have passed or deepened, so the policy is mistimed.

These restrictions mean fiscal stimulus often delivers less, and later, than intended.

Part (b) — Are demand-side policies less appropriate than supply-side for low unemployment in Singapore? [15]

A low rate of unemployment requires policies matched to the type of unemployment present. Whether demand-side policy is less appropriate than supply-side depends on which type dominates and on the restrictions identified in part (a).

Demand-side policies for cyclical unemployment. Cyclical (demand-deficient) unemployment arises when a fall in AD opens an output gap. Singapore responds with expansionary fiscal policy (e.g. the 2009 Resilience Package) alongside an exchange-rate easing: a zero-appreciation stance makes exports cheaper and imports dearer, and since the Marshall–Lerner condition holds, net exports rise.

The restrictions from part (a) bite here: Singapore’s small multiplier (high import leakage) limits the income gain, and demand-side policy cannot touch unemployment that is structural rather than cyclical.

Supply-side policies for structural unemployment. Structural unemployment reflects a skills mismatch as the economy’s structure shifts — technology accelerates skills obsolescence. Supply-side policy such as the Adapt and Grow scheme retrains workers for growth sectors, reducing the mismatch and raising potential output. Its limitations: it requires substantial government funding and depends on workers’ attitudes and aptitudes, and it works only over the long run.

Judgement. Demand-side and supply-side policies are not ranked in the abstract — they address different unemployment, cyclical and structural respectively, so the question of which is “less appropriate” can only be answered against the prevailing economic conditions. In a recession driven by collapsing external demand, demand-side policy (fiscal plus exchange-rate easing) is the more appropriate front-line tool, despite the small-multiplier and time-lag restrictions, because it directly tackles the dominant cyclical unemployment. But for Singapore’s persistent unemployment — structural, driven by technological change and skills obsolescence — supply-side policy is indispensable and demand-side policy is largely powerless. The defensible verdict is therefore conditional: demand-side policy is not generally less appropriate, but it is less appropriate for the structural unemployment that increasingly characterises a mature, open economy like Singapore. The two are complements — demand-side measures to close cyclical output gaps in the short run, supply-side measures to address structural mismatch in the long run — with the appropriate emphasis set by the root cause of the unemployment at hand.